CARSON ESTATE CO v. MCCOLGAN FRANCHISE TAX COM

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District Court of Appeal, Second District, Division 1, California.

CARSON ESTATE CO. v. MCCOLGAN, FRANCHISE TAX COM'R.

WATSON LAND CO. v. MCCOLGAN, FRANCHISE TAX COM'R.

Civ. No. 13697.

Decided: October 21, 1942

George G. Witter and Mackay, McGregor & Reynolds, all of Los Angeles, for appellants. Earl Warren, Atty. Gen., H. H. Linney, Asst. Atty. Gen., and Adrian A. Kragen, Deputy Atty. Gen., for respondent.

By stipulation the above entitled cases were consolidated for trial. Judgment was entered for the defendant in both actions and the plaintiffs appeal. It was stipulated that the appeals in both cases might be prosecuted and determined upon a consolidated record. The actions in question were brought to recover California state franchise taxes measured by the income of the respective appellants for the calendar years 1932 to 1936, inclusive, in the case of Carson Estate Company, and for the calendar years 1933 to 1935, inclusive, in the case of Watson Land Company. During the years here involved both of the plaintiffs were California corporations and stockholders of Francis Land Company, another California corporation. In each of said income years appellants, respectively, received dividends from Francis Land Company. Said dividends, in turn, were admittedly derived from income of Dominguez Estate Company, wholly earned by that company from business done within the State of California and upon which said Dominguez Estate Company paid a franchise tax.

Both appellants filed their franchise tax returns regularly each year, reporting the full gross income earned or received by them, including the dividends from Francis Land Company. They then deducted such dividends from the gross income reported on their returns, in reliance upon the provisions of section 8(h) of the California Franchise Tax Act, Stats.1929, ch. 13, p. 19, as amended, St.1935, p. 964, Deering's Gen.Laws, Act 8488, which, so far as here pertinent, then provided as follows: “§ 8. In computing ‘net income’ the following deductions shall be allowed: * * * (h) Dividends received during the income year from a bank or corporation doing business in this State declared from income arising out of business done in this State; but if the income out of which the dividends are declared is derived from business done within and without this State, then so much of the dividends shall be allowed as a deduction as the amount of the income from business done within this State bears to the total business done. The provisions of this subdivision shall not apply to dividends received from * * * corporations not taxable under Article XIII of the Constitution of this State. The burden shall be on the taxpayer to show that the amount of dividends claimed as a deduction has been received from income arising out of business done in this State.”

The franchise tax commissioner disallowed the deduction of the dividends so received from Francis Land Company on the ground that Francis Land Company was not a “bank or corporation doing business in this State.” Appellants paid the resultant deficiencies under protest and filed claims for refund covering such payments. In due time, following the rejection of said claims for refund, these actions were commenced.

The trial court found that the Francis Land Company was not doing business in the years 1933, 1934, 1935 and 1936, or in any of those years; that the Francis Land Company did not actively engage in any transaction for profit in the years 1933, 1934, 1935 and 1936, or in any of those years; and concluded that the dividends received by appellants were not deductible under section 8(h) of the Bank and Corporation Franchise Tax Act (supra) as it read in 1933, 1934, 1935 and 1936, and that appellants did not overpay their franchise taxes for the years mentioned. Appellants and respondent agree that the decisive question here presented is whether Francis Land Company was “doing business” during the years in question, within the meaning of that term as defined by the Bank and Corporation Franchise Tax Act, supra.

Francis Land Company was organized under the laws of California on the first day of August, 1928, with an authorized capital of $500,000. Its principal place of business was Los Angeles, California. It had five directors. Among the purposes stated in its articles of incorporation, are the following: To buy and sell and trade in real estate and in all kinds of personal property, to acquire shares of corporate stock and obligations of other corporations, and to sell or exchange the same for other property. Soon after its organization it acquired substantial holdings in the stock of Dominguez Estate Company. The latter was a California corporation, whose income, as hereinabove noted, was earned wholly from business done within the State of California. Dominguez Estate Company paid a franchise tax on its full income each year to the State of California. Francis Land Company during the years in question occupied offices which were also occupied by Dominguez Estate Company, and its employees were also employees of Dominguez Estate Company. Francis Land Company paid a portion of the salaries of such employees. Dominguez Estate Company paid a larger portion. The Board of Directors of Francis Land Company met once a month, and oftener when occasion required. The record reveals the following transactions entered into by the Francis Land Company. December 14, 1933, said company purchased $20,000 par value Albany & Susquehanna bonds, for a total of $16,643.88, and sold $12,000 par value of said bonds on January 2, 1934, realizing therefor $16,678.88. Certain shares of Continental Can Company stock were purchased on March 20, 1935, and sold on April 1, 1935, realizing a profit of $374.85. A similar purchase of other stock on March 20, 1935, with a sale thereof on April 9, 1935, brought a profit of $88.43. The purchase on April 1, 1935, and the subsequent sale on April 12, 1935, of another block of stock, resulted in a profit of $209.71. Nine other such purchases were made in 1935, and the stock in each instance was subsequently sold within a relatively short period from the purchase, the profits ranging from around $700 to about $178, with one loss of $398.13. Two such transactions occurred in 1936, one resulting in a loss of $611.57, the other in a loss of $149.09. The Board of Directors of Francis Land Company appears to have given its officers a general authorization to purchase the securities mentioned. During the years in question, other than the above transactions, the affairs of the Francis Land Company appear to have been concerned with the collection of dividends on stock of Dominguez Estate Company and the paying out of dividends derived from such income. Appellants have offered no other evidence in support of their claim. Appellants contend that the above facts are sufficient to show that the Francis Land Company was “doing business” as that term is defined by the provisions of the Bank and Corporation Franchise Tax Act; and that appellants were therefore entitled to deduct the dividends in question received from the Francis Land Company, in determining the measure of their own franchise tax.

Respondent points to the small proportion the foregoing stock and bond transactions bore to the total assets of the Francis Land Company, and to the small percentage of gain received therefrom in relation to total income; also to the fact that there were no such transactions in 1932. Respondent also contends that when the organizational setup of the Francis Land Company is considered the conclusion that it was not “doing business” is further strengthened, since, according to respondent, it appears that the corporation had only one paid employee, who received one–seventh of his total compensation from Francis Land Company. However this may be, the status of the Francis Land Company must be determined by the statutory definition of the term “doing business” as contained in the Bank and Corporation Franchise Tax Act during the periods mentioned. Respondent claims that appellants' contention, that the definition of “doing business,” contained in section 5 of the act, necessitates a conclusion that the Francis Land Company was “doing business,” is clearly contrary to the decision in Union Oil Associates v. Johnson, 2 Cal.2d 727, 43 P.2d 291, 98 A.L.R. 1499. Before entering into a discussion of the cited case it is advisable to set forth the pertinent provisions of the Bank and Corporation Franchise Tax Act, supra, in effect during the years here in question.

After amendment, effective August 14, 1931, section 5 of said act, containing definitions of terms used therein, read in part as follows: “The term ‘corporation,’ as herein used, shall include every financial corporation, other than a bank or banking association, and every mercantile, manufacturing and business corporation of the classes referred to in subdivision 1(c) of section 5219 of the revised statutes of the United States [12 U.S.C.A. § 548, subd. 1(c)]. * * * The term ‘doing business,’ as herein used, means any transaction or transactions in the course of its business by a corporation created under the laws of the state, or by a foreign corporation qualified to do or doing intrastate business in this state, and shall include the right to do business through such incorporation or qualification.” Stats.1931, ch. 1066, p. 2225. By amendment in effect May 1, 1933, said portions of section 5, supra, were changed to read as follows: “The term ‘corporation,’ as herein used, shall include every financial corporation, other than a bank or banking association, and every mercantile, manufacturing and business corporation of the classes referred to in subdivision one (c) of section 5219 of the Revised Statutes of the United States, and every corporation subject to be taxed pursuant to section 4 hereof. * * * The term ‘doing business,’ as herein used, means actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” Stats.1933, ch. 210, pp. 692, 694.

By amendment in effect May 1, 1933, a new paragraph was added to section 4 of the act in question, reading as follows: “Any corporation organized to hold the stock or bonds of any other corporation or corporations, and not trading in such stock or bonds or other securities held, and engaging in no other activities than the receipt and disbursement of dividends from such stock or interest from such bonds, shall not be considered a financial, mercantile, manufacturing or business corporation or a corporation doing business in this State for the purposes of this act.” Stats.1933, ch. 210, pp. 692, 693. Effective June 6, 1935, this paragraph of section 4 was amended to omit reference to “a financial, mercantile, manufacturing or business corporation,” so that a holding company, as defined therein, should thereafter merely not be considered a corporation doing business in this state for the purposes of the act in question. Effective on the same date the first paragraph of section 5 was changed to read as follows: “The term ‘corporation,’ as herein used, shall include every corporation, other than a bank or banking association, and other than those expressly exempted from the tax by the provisions of this act or the Constitution of the State of California.” Stats.1935, ch. 275, pp. 959, 962.

Union Oil Associates v. Johnson, supra, was a case in which the plaintiff, a California corporation, brought an action to recover taxes levied against plaintiff for the year 1931 under the Bank and Corporation Franchise Tax Act. Plaintiff there was a holding company organized under the laws of this state to own and hold stock of an oil company and distribute dividends paid thereon to its own stockholders. At the time of the levy of the tax there in question section 5 of the Bank and Corporation Franchise Tax Act defined the term “doing business” as follows: “The term ‘doing business,’ as herein used, means any transaction or transactions in the course of its business by a corporation created under the laws of this state, or by a foreign corporation qualified to do or doing intrastate business in this state.” Stats.1929, ch. 13, p. 20, supra. In the cited case the defendant state treasurer demurred to the complaint on the ground that it did not state a cause of action. The court below overruled the demurrer, and upon defendant's failure to answer entered judgment for the plaintiff. The Supreme Court affirmed this judgment, Mr. Justice Thompson dissenting with the concurrence of Mr. Justice Shenk. The basis for the opinion of the majority of the court is revealed by the following quotation from the case (2 Cal.2d at page 733, 43 P.2d at page 294, 98 A.L.R. 1499 et seq.):

“* * * the constitutional amendment approved by the people on November 6, 1928, provided for a tax according to or measured by net income to be paid by banks and by certain corporations doing business within this state.

“Both the constitutional provision and the Bank and Corporation Franchise Tax Act provide that ‘financial, mercantile, manufacturing and business' corporations ‘doing business within the limits of this state’ shall pay the tax. (Italics supplied.) Thus our state constitutional provision and legislation adopt the language of that portion of section 5219, Revised Statutes [United States], by which the validity of a tax upon national banking associations according to or measured by net income is made to depend upon the rate being not ‘higher than the rate assessed upon other financial corporations nor higher than the highest of the rates assessed by the taxing State upon mercantile, manufacturing, and business corporations doing business within its limits. * * *’ Not only in enumerating the classes of corporations subject to the tax did the Legislature adopt the language of section 5219, but in defining the term ‘corporation’ it expressly refers to said section 5219. * * * The ‘classes referred to in subdivision one (c) of section 5219,’ are ‘financial corporations' and ‘mercantile, manufacturing and business corporations doing business within its (the state's) limits.’ Hence, plaintiff argues, it was the intent of the people and the Legislature that the interpretation placed upon the phrases ‘business corporation’ and ‘doing business' by the federal courts should govern our state provisions, with the result that a holding company is not a ‘business corporation.’ We are in accord with this contention. * * *

“There can be little doubt that the Supreme Court of the United States in construing the meaning of the terms ‘doing business' and ‘business corporations' in subdivision 1(c) of section 5219, Revised Statutes, which authorizes a state excise tax upon national banking associations, would follow the definition given by it to those terms as used in the Tax Acts of 1909, 1916, and subsequent years establishing federal excise taxes. It is a cardinal principle of statutory construction that where legislation is framed in the language of an earlier enactment on the same or an analogous subject, which has been judicially construed, there is a very strong presumption of intent to adopt the construction as well as the language of the prior enactment. [cases cited.] * * *

“In the instant case our constitutional amendment and legislation were enacted to establish a mode of taxation which would comply with the federal permissive statute. The presumption that the adoption of the words of the federal enactment evinces an intent to adopt the federal construction thereof is even stronger than in the ordinary case where legislation of one jurisdiction is merely modeled after that of another. * * *

“In the light of this analysis the purpose of the Legislature in adopting the 1933 amendment to sections 4 and 5 of the act, quoted earlier herein, and providing that such a holding company as plaintiff shall not be considered a ‘business corporation,’ was to clarify the legislative intent by expressly declaring the meaning of the words used in the act. * * * We have heretofore held that this state has adopted the federal definition, and that the amendment of 1933 is a clarification and legislative expression of the meaning of existing legislation. Plaintiff, upon the basis of the allegations of its complaint is not a business corporation according to said amendment. It is organized to hold the stock of the Union Oil Company, and does not trade in such stock, and engages in no other activities than the receipt and disbursement of dividends.”

It may be seen from the foregoing excerpt that the majority of the Supreme Court arrived at the decision in the case cited by first discovering a legislative intent to adopt a federal definition of the term “doing business” in the Bank and Corporation Franchise Tax Act as it existed prior to 1933 and then concluding that the 1933 amendment was merely an expression of the legislative intent which had previously existed. By this procedure the court found justification for applying the provisions of the 1933 amendment to a situation which arose prior to the adoption of that amendment. In any event, it is reasonably clear that the cited case was decided through an application of the provisions of the Bank and Corporation Franchise Tax Act hereinabove quoted, as amended in 1933. Union Oil Associates v. Johnson, supra, therefore, does not serve to refute the contention of appellants that the definition of “doing business” in section 5 of the act in question necessitates the conclusion that Francis Land Company was “doing business” in the years here involved, since that case itself makes use of the definition contained in the act.

The question has been quite recently presented in the case of Oliver Continuous Filter Co. v. McColgan, 48 Cal.App.2d 800, 120 P.2d 682, 684. That case concerned an appeal from a judgment for the state treasurer, for whom the franchise tax commissioner was substituted, in an action for the recovery of a corporation franchise tax paid under protest in the year 1931. There, plaintiff, organized under the laws of the State of California, was actively engaged in the business of manufacturing and selling filters and allied machinery and equipment. The United Filters, Incorporated, a Delaware corporation, conducted a like business in Pennsylvania. To effect a merger of the two companies, Oliver United Filters, Inc., was incorporated under the laws of the State of Nevada, and immediately qualified to do business in this state. To such company, plaintiff transferred all of its assets, except cash in the sum of $20,000, receiving therefor stock in the new Nevada corporation. The Delaware corporation likewise assigned its assets to the Nevada corporation, and received stock therefor. Plaintiff immediately distributed to its stockholders as dividends part of the stock acquired, retaining, however, a portion thereof, on which it received dividends, disbursing them from time to time to its stockholders. This stock, together with the $20,000 cash retained, as above, constituted plaintiff's only asset, and, although it still retained all powers granted under its articles of incorporation, it did not actively engage further in the business it had previously conducted. The income of plaintiff for the years 1929, 1930 and 1931 consisted of dividends from the stock of the Nevada corporation, and interest on loans made to that corporation by it, also on loans to its own principal stockholder, and to a number of its former employees made to enable them to retain stock of the Nevada corporation for which they had previously subscribed, and which stock the plaintiff held as security. After May, 1928, the plaintiff maintained no offices, and had no salaried employees, its only expense being that for bookkeeping services. Subsequent to the transfer of the assets of plaintiff corporation to the Nevada corporation, the former was kept alive so that stock it so owned could be voted as a unit at meetings of the Nevada corporation. In the year 1931 plaintiff paid the minimum franchise tax of $25 specified by law. Some time thereafter, upon demand, it paid to the commissioner under protest an additional sum of $7,174.88, based upon dividends received from the Nevada corporation on business transacted by that company out of the state, and upon interest received from loans. The additional assessment was made upon the theory that plaintiff was a business corporation actively doing business in California. The appellate court considered the case as one coming under the provisions of section 5 of the Franchise Tax Act as amended by Statutes of 1931, chapter 1066, page 2225, above quoted, wherein the definition of the term “doing business” included the “right to do business.”

The court pointed out the distinction between the case before it and that of Union Oil Associates v. Johnson, supra, stating: “In the Union Oil case, unlike the present, the corporation charter had been amended to limit its functions to those of a holding company. It was held at page 735 of 2 Cal.2d, at page 295 of 43 P.2d, 98 A.L.R. 1499, that ‘the state might have provided that holding companies should be subject to the tax along with other corporations. * * *’ ”

One of the questions presented to the court in the Oliver Continuous Filter case, supra, was the constitutionality of the provision which required that “doing business” shall “include the right to do business.” The court found such an enactment within the scope of authority conferred by constitutional amendment (Const. art. XIII, § 16), pointing out that: “The tax referred to therein was not placed on ‘doing business' except to the extent of fixing the amount of such tax as the equivalent to four per cent of net income, which is incidental to the main purpose of the constitutional amendment, namely, that a tax may be levied on the privilege or right of exercising a corporate franchise in this state.”

Of the application of the provisions of section 5 of the act, as then amended, to the plaintiff there, the court stated:

“Sections 4 and 5 of the act simply sanction a tax upon a business corporation. The sections provide that the tax shall be fixed upon the basis of net income, and that in any event each such corporation shall pay a minimum tax of twenty–five dollars. In this case plaintiff's articles of incorporation provided that it was organized for the purpose and with the privilege and right, among other things, to buy, sell, transfer, invest and deal in real estate, stocks, bonds and personal property of every kind and character; to lend and borrow money and to engage and carry on the business of manufacturing, constructing and assembling machinery.

“As applied to appellant corporation, if no business should be transacted, or if the net income should be less than a tax thereon justifying twenty–five dollars, the specified minimum is payable, otherwise the tax for the privilege or right to do business is measured by net income for the next preceding fiscal or calendar year, computed at the rate of four per cent. § 4.

“The legislature directed, pursuant to constitutional authorization, that corporations during 1931–1933 incorporated for the purpose of doing business should pay a tax for the right to do business. In the Union Oil case the corporation did not have the right to do business. Appellant herein was organized for the purpose of doing business, and actually engaged therein. Appellant cites cases which are not directly in point. Rose v. Nunnally Inv. Co., 5 Cir., 22 F.2d 102 [cited with approval in the Union Oil case, and also cited by respondent in the case at bar], however is worthy of mention. That case dealt with a reorganized corporation. Transactions similar to those in the present case were held not to be included in the term ‘doing business' upon the theory that a tax is based, not upon charter powers, but upon its activities. That rule may not be applied under the provisions of a statute wherein the test is the ‘right to do business.’ In the latter instance, necessarily the charter powers determine the scope of activity.

“The words ‘right to do business' may have given rise to some doubt, and in 1933 reference to the ‘right’ was eliminated, the definition then reading: ‘The term “doing business,” as herein used, means actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.’ Stats.1933, ch. 210, page 694. It is not necessary to discuss the change. The present case deals solely with the 1931 definition.”

The appellate court in the quoted case accordingly affirmed the judgment in favor of the defendant state treasurer. A petition for a hearing by the Supreme Court was denied.

Because of the period of time involved in the case at bar the situation here presented is concerned both with the 1931 amendment considered in Oliver Continuous Filter Co. v. McColgan, supra, and the 1933 amendment to the Franchise Tax Act. The 1933 amendment is specific in its terms, both as to the definition of the term “doing business” (§ 5), and as to corporations “organized to hold the stock or bonds of any other corporation” (§ 4). See Stats.1933, ch. 210, pp. 692, 693, quoted above. There is little room for judicial construction without distorting the plain purport of the language. To hold that Francis Land Company was not “doing business” is to indulge in such a distortion of the plain meaning of the statute.

According to the record presented, Francis Land Company traded in “other securities,” at least to the extent shown, and thus engaged in “other activities than the receipt and disbursement of dividends” from stock held by it, within the meaning of section 4 of the act as quoted. Section 4 plainly limits the classification of holding company to corporations which engage in “no other activities” than the receipt and disbursement of dividends from stock or interest from bonds held. The statute as written is absolute in effect and permits no degrees of activity in this respect. Francis Land Company, upon the evidence, cannot be considered a holding company within the meaning of section 4 of the act. Nor may it reasonably be said that Francis Land Company did not “actively [engage] in any transaction” within the meaning of section 5 of the Franchise Tax Act as amended in 1933, supra. As employed in the definition of the phrase “doing business” the adverb “actively” cannot be taken to denote “brisk,” “lively,” “characterized by frequent activity,” as in speaking of an active market. If taken in that sense, the statutory definition is virtually rendered meaningless and impossible of any practical application, since the Legislature has therein employed the term “transaction” in the singular. Under the circumstances, “actively” must there be taken to mean “active” as opposed to “passive,” or “active” as opposed to “inactive.” Thus, “actively” as used in section 5, supra, denotes “taking an active part in any transaction,” “actually engaging in any transaction.” In this sense, the adverb “actively” takes on a distinct meaning and gives significance to the definition set forth in the statute. It is in this sense that the word “actively” must be construed as employed in the definition of “doing business” contained in section 5 of the Franchise Tax Act as amended in 1933; and in this sense Francis Land Company was “doing business” when it engaged in the transactions shown by the record. It does not appear that Francis Land Company engaged in the transactions mentioned for any other purpose than that of financial or pecuniary gain or profit; and profit therefrom was shown. The construction placed upon the 1931 amendment by Oliver Continuous Filter Co. v. McColgan, supra, requires a holding that under that amendment the Francis Land Company was a corporation “doing business.” As appears from the provisions of its charter the Francis Land Company clearly had the right to do business. It might be pointed out that franchise tax returns of that corporation, filed herein as exhibits, indicate that the Francis Land Company, for the years in question, paid a franchise tax on the basis of a corporation “doing business.”

It follows that, upon the facts presented, the trial court was not warranted in finding that the Francis Land Company was not doing business in the years mentioned. None of the findings and conclusions of the trial court are supported by the evidence. Upon the facts presented, only one conclusion is possible under the governing provisions of the Franchise Tax Act, namely, that the Francis Land Company was a corporation doing business in this state for the purposes of the act and within the meaning of the term as defined by the act.

The judgment is reversed with directions to the trial court to enter judgment in favor of appellants for the tax refunds as prayed.

DORAN, Justice.

YORK, P. J., and WHITE, J., concurred.

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